No. of Recommendations: 4
Acacia Communications (ACIA)

This is my first look at ACIA. It was a high flyer and has come down recently, as has the competition. This is part of the Broadband revolution that is going on now and it makes devices for the long haul, metro, and DCI market. Specifically they make modules for the Transport network. They have been public for two quarters right now so we can’t get a good feeling of their growth but if you are interested in the expansion of bandwidth you might be interested in this market. They do in a sense compete with Infinera but the reason that I became interested in them is that they do build products for a company in China so this give them a foothold in China where a lot of growth is going on. I do own shares in this company so I am talking my book. Any thoughts are greatly appreciated.

What do they do?

Acacia’s modules are rooted in its low-power coherent DSP ASICs and silicon PICs, which Acacia has specifically developed for its target markets. Acacia’s coherent DSP ASICs and silicon PICs are manufactured using CMOS and CMOS-compatible processes. Using CMOS to siliconize optical interconnect technology enables Acacia to continue to integrate increasing functionality into its products, benefit from higher yields and reliability associated with CMOS and capitalize on regular improvements in CMOS performance, density and cost.

To break this down they produce application specific chips and silicon Photonic Integrated Chip. This means they can put different parts of the photonic transport functions on a chip. They make Pics based on silicon and Infinera makes chips based on indium phosphide. I am not going to make try to explain why one might be better than the other, because frankly, I have no idea which is better. But here is a blog on Infinera and what might be holding them back.

http://fibereality.com/blog/infineras-pic-challenge/

This isn’t an article on Infinera though but on ACIA. What makes me interested in them is that they have business with ZTE which is a Chinese network transport company. They do a lot of business with them, in fact they had 35% of their business with them last quarter I believe. But in March the United States slapped trade restrictions on ZTE. They then lifted those restrictions temporarily. You can read about this here.

http://www.wsj.com/articles/u-s-plans-to-place-restrictions-...
http://www.wsj.com/articles/u-s-to-provide-temporary-trade-s...

Another part of this that is concerning is if a trade war develops with China. It is hard to quantify what will happen because there has been a lot of smoke in the last year without much hard substance. But Acacia doesn’t break out how much each of their customers are in revenue but this quarter they had two over 10% customers. One was 35% and the other was 28.3%. This is concerning but they are trying to grow their customer base. When doing a cursory look at their competitors it seems this is par for the course. The customers that Acacia has is ZTE, ADVA, Coriant(private), CSCO and their rivals are OCLR, FNSR, LITE, NPTN, AVGO, and in a sense INFN.

Another thing that has me interested in this company is that they have gross margins in the high 40% on a non-gap basis and high 40% on a gap basis. They plan on raising this into the low 50%. Only one of their competitors has as high gross margins as ACIA and that is Broadcom (AVGO) but they are in so many different parts of the chip market that it is difficult to see exactly what their margins are just in the Network transport division. OCLR, which also does a lot of business in China has gross margins in the low 30% range, FNSR has gross margins in the High 30% range, Lite has Gross margins in the low 30% range, NPTN has gross margins in the high 20% range and of course AVGO has gross margins in the high 40% range. It’s surprising that Acia has such high margins when the rest of the group is so small but let’s see why that maybe.

According to their 10Q this quarter one of the reasons that their cost of revenues went up is because they sold so much more product. This is true because their Revenue went up 106.8% Y/Y. They raised their outlook 3 times this quarter. So while their costs are going up ,79% YoY, their revenues are growing much faster. Another thing that helps them is they also have the PIC technology. This allows them to put more components on one chip which lowers their cost. But they are not vertically integrated so they do have risk in the sense that they could be supply constrained if they cannot get their product from their manufactures. This happened to OCLR recently and if ACIA can’t manage their supply chain it could lower their growth. Their Earning per share though was down from $3.42 to $1.01 on a non-Gaap basis and up from .20 to .86 on a Gaap basis. They just recently IPO’d and the reason for this was the ballooning in Diluted shares. Although they were much more profitable this quarter than a year ago they also have more shares. I do not find this concerning because when a company does IPO a lot of costs do come out and it is hard to analyze a company.
So what makes this company different, and why do I think they will do well in this upgrade of the Network cycle. First they have the Silicon Pic and this cuts their costs. They just recently introduced a 400 gig module based on the technology. Second they can sell into China which is growing through a big cycle that some of the companies are missing out on. Third, they are not platform agnostic, they can sell to anyone who needs their photonic modules.

What would be a reason not to buy this stock. A trade war with China would hurt unless they could pick up more customers in other parts of the world. If the United States puts trade restrictions on ZTE or any other Chinese companies. If they lose one of the manufactures of their product or if they can’t provide enough product.

I have opened a small position in this company as I learn more about them. They have only been on the market for 2 quarters so I consider them to be very risky.

Andy
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